India's central bank lifted interest rates for a second straight month and rolled back the liquidity tightening measures on Tuesday, as Governor Raghuram Rajan stepped up the fight against rising inflation.

The repo rate, which is the rate at which the Reserve Bank of India lends to banks, was raised by a quarter point to 7.75 percent, Rajan said in a statement.

The RBI adjusted the reverse repo rate to 6.75 percent from 6.50 percent. The reverse repo rate is the rate at which the bank accepts deposits from banks.

In order to improve liquidity in the banking system, the central bank decided to lower the marginal standing facility (MSF), to 8.75 percent from 9 percent with immediate effect.

The MSF rate is the rate at which scheduled banks can borrow funds overnight from the RBI and was introduced in May 2011. The rate was hiked by a massive 200 basis points in July this year to halt a slump in the rupee.

Today's policy decisions were in line with economists' expectations.

Further, the bank rate was lowered to 8.75 percent from 9 percent. Thus, the MSF rate and the Bank Rate are recalibrated to 100 basis points above the repo rate, the RBI said.

With the reduction of the MSF rate and the hike in the repo rate, the process of re-aligning the interest rate corridor to normal monetary policy operations is now complete, Rajan said.

The bank also decided to increase the liquidity provided through term repos of 7-day and 14-day tenor to 0.5 percent of net demand and time liability of the banking system from 0.25 percent with immediate effect.

Full removal of the tightening measures would mean the repo rate would resume its role as the operational policy rate, said Daniel Martin, an economist at Capital Economics. He expects the RBI to take this step before the end of the year, as long as the rupee remains stable.

Rajan, a former International Monetary Fund chief economist, surprised the markets with a rate hike last month at his first monetary policy review. He has cut the MSF by 125 basis points, after taking the helm at the central bank in September.

The RBI today kept the cash reserve ratio (CRR) unchanged at 4.00 percent. The bank had last reduced the CRR by 25 basis points in January.

The RBI expects wholesale price inflation to remain at higher than current levels through most of the remaining part of the year, warranting an appropriate policy response. In September, wholesale price inflation rose to a seven-month high of 6.46 percent on higher food prices.

At the same time, consumer price inflation is forecast to remain around or even above 9 percent in the months ahead, "absent policy action", the RBI said. That was the first CPI inflation forecast given by the central bank.

"It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth," Rajan said.

Strengthening export growth and signs of revival in some services, along with the expected pick-up in agriculture, could support an increase in growth in the second half of 2013-14, the bank said.

Nonetheless, the RBI downgraded the country's real economic growth for FY 2014 to 5 percent from 5.5 percent.

The central bank's estimate stands well above the projection of international agencies. Early October, the International Monetary Fund cut India's growth forecast for this year to 3.8 percent from 5.6 percent. Next year, growth is projected at 5.1 percent.

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